Hong Kong: They are classic Hong Kong stories: people who, in a blink, became stock-market billionaires.

But exactly what’s behind much of this wealth is something of a mystery.

Take Wong Wing-wah, who used to be a fishmonger before starting a civil engineering firm. He took his company public last year — and its stock then soared 9,800 per cent. Wong and a partner, who together own nearly all of the stock, are each now worth roughly $1 billion (Dh3.67 billion).

Their company, Luen Wong Group Holdings Ltd, reported just $1 million in profit last year.

What’s going on? The answer lies in one of the murkiest corners of Hong Kong finance: small-cap stocks.

The Hong Kong Stock Exchange and its sibling, the Growth Enterprise Market, have become a breeding ground for paper billionaires.

In the past three years alone, perhaps as many as a dozen executives, many from mainland China, have amassed billion-plus wealth as their companies’ share prices soared, usually for no apparent reason.

The executives and their companies haven’t been accused of wrongdoing. But the phenomenon has raised flags for Hong Kong regulators, who warn that the stocks can be susceptible to manipulation, particularly when few of the shares are in the public’s hands.

Wild swings

In some cases, the public float of these companies is effectively less than 1 per cent, leading to wild price swings and gaping differences between the prices at which investors are willing to buy and sell. In the case of Luen Wong, the bid-offer spread recently hit 68 per cent.

“A lot of these guys are very rich on paper, but if they were to sell their shares, there’s no way they would be able to realise any of the consideration of the share price,” said Philippe Espinasse, the Hong Kong-based former head of Asia equity capital markets at Nomura Holdings Inc. and author of IPO: A Global Guide.

Again and again — 124 times since 2009 — the Securities and Futures Commission has warned about what it calls “high shareholding concentration,” where most of a company’s stock is held in few hands, and where low trading volumes and triple-digit gains signal investors to be cautious. The companies’ market value totalled $79.6 billion as of the dates of each of the notices.

Extreme caution

In April 2016, after Luen Wong began trading, the SFC recommended “extreme caution” in buying its shares because 96 per cent of them were held by its two founders and 19 other investors. Yet shares are currently trading more than 7,500 per cent higher than their IPO price. The PE, or price-to-earnings ratio, is now an extraordinarily high 2,450 in a city where the benchmark index median for small-cap stocks is 13.

Hong Kong companies, which are often family-run, have been using various means to artificially inflate their share prices, according to Jie Gan, a Hong Kong-based finance professor at Beijing’s Cheung Kong Graduate School of Business, who was speaking generally. “And now mainlanders are also coming here and using similar tricks or gimmicks to maximise their wealth.”

Thorough review

A representative for the SFC and a spokesman for both exchanges declined to comment. Since a speech last June, when SFC Chief Executive Officer Ashley Alder said the regulator and bourse operator Hong Kong Exchanges & Clearing Ltd were working to review and possibly enhance listings supervision, the two bodies issued several statements over general exchange misconduct.

Hong Kong has also been stepping up scrutiny of its markets. The SFC has been doubling enforcement staff since 2010 to more than 200 people as of next year.

New funding

A high market value, even if it’s an unwitting side effect of concentrated ownership, helps a company’s principals court new business as well as funding sources they might not otherwise tap.

“Even if they’re just a billionaire on paper, they’re still able to access hundreds of millions that are not due them in real money,” said Dan David, a co-founder of Pennsylvania-based research firm GeoInvesting and an investor in, and short-seller of, Hong Kong stocks.

Shares of all the paper billionaires’ companies have traded between 5 and 335 times their respective book values. Hong Kong companies ranged between 1 and 1.3 last year.

The most recent possible paper billionaire is Yam Yu, whose 35.6 per cent stake in International Business Settlement Holdings Ltd is valued at almost $1.5 billion, though the company has been unprofitable for most of the nine years that he’s been its largest shareholder.

As the value of Yam’s stock was surging more than 180 per cent last year, he sold HK$2.6 billion ($335 million) worth of shares to Luo Feng, who had been appointed chairman. IBS then raised HK$1.6 billion through a share placement. Luo and Yam weren’t available to respond to questions, according to a company spokeswoman.

Yam acquired his stake in 2007, when the company made ladies’ garments. Since then, the business has changed its name twice while moving into various unrelated industries including water dispensers, purification equipment, a gold mine in Kyrgyzstan, consulting, e-commerce and property development. Its current venture is an international payment system that uses blockchain technology and big data.

Three warnings

The SFC has issued three concentrated shareholding warnings about IBS and its predecessor. A spokeswoman for IBS said the stock’s performance is a reflection of investors’ confidence in its latest business and disputed the regulator’s characterisation of its shareholding.

The most prominent tycoon to have his companies issued with the SFC’s warning, in 2015, is Pan Sutong, who was formerly the fourth-richest person in Asia, according to the Bloomberg Billionaires Index. The value of Pan’s stakes in Goldin Properties Holdings Ltd and Goldin Financial Holdings Ltd soared to $27 billion in the first half of 2015 before plunging to nearly a 10th of that value. In March last year, Pan pledged his entire stake in Goldin Properties for a line of credit that reduced his net worth below the threshold for the Index.

Goldin Properties’ trading was suspended for a week in March prior to Pan’s announcement that he intended to take it private. A spokesman for the company didn’t address questions about Pan’s valuation.

Index exclusion

The paper billionaires’ companies were dropped from the indexes compiled by FTSE Russell, MSCI Inc. and Hong Kong’s Hang Seng, when they began announcing in 2015 that companies flagged by Hong Kong’s regulator would no longer be eligible. To be reinstated, the MSCI said it would need to confirm their free floats had returned to an acceptable level of 15 per cent. None has been verified to have done so yet.

Also dropped for that reason was the Chinese operator of a casino on the US territory of Saipan, Imperial Pacific International Holdings Ltd. A spokeswoman for Imperial Pacific disputed the SFC’s characterisation of its shareholders, referred to its public filings and said controlling shareholder Cui Lijie had reduced her stake.

Luen Wong, with a market value of $3 billion, was established in 1998 with HK$20,000. Wong Wing-wah’s rags-to-riches story was highlighted by his daughter Priscilla, a local television actress, in a Facebook post last year.

“His body suffered for so many years, from frozen hands to sore feet,” she wrote when the company went public.

With Luen Wong’s tiny public float of about 4 per cent as of the time of the SFC’s warning, it would be difficult for investors to participate in Wong’s success even if they wanted to.

“What is the reason for being public in the first place?” said David of GeoInvesting. “Your stock can only go up, unless you’re going to be the one dumping your own holdings.”

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